Belmont Club

All The Lies in China

Ambrose Evans-Pritchard thinks the Chinese economy is running out of oomph. “Is this the long-feared hard landing? Of course it is.” He writes:

China is on the cusp of a deflationary vortex.

This was signalled late last year by the sharpest contraction in the (real) M1 money supply since modern records began. The hard data is now confirming the warnings …

The World Bank says China still has plenty of scope for fiscal largesse – cutting taxes and boosting spending – so it should at least avert full depression. If only the West were so lucky.

But at the end of the day, the country is bursting with industrial over-capacity. As Caixin reported recently, eight of the ten largest shipyards did not receive any new orders in the first five months of the year.

Albert Edwards from Societe Generale said the danger now is that China suddenly lurches into a deeper downturn, unleashing a flood of excess goods onto global markets and sending a powerful deflationary impulse across the world.

It sounds like bad news. But one analyst says there’s worse to come. He argues that recent emergence of “the hard data” has come despite and not because of the problem. A China analyst quoted by Evans-Pritachard contends that while there are many anecdotal indicators that the Middle Kingdom’s economy is slowing down, the chief uncertainty is that many of countries financial transactions take place in in the dark; that is, the opaque world of the Chinese shadow banking system.

The term shadow banking system refers to “the collection of financial entities, infrastructure and practices which support financial transactions that occur beyond the reach of existing state sanctioned monitoring and regulation. It includes entities such as hedge funds, money market funds and structured investment vehicles (SIV).”

In China, elements of the shadow system guarantee loans for each other. “This is exactly what’s happened. Tianyu Construction Co. went bust early this year, and because of the complex web of connections where companies guaranteed loans for each other, a large number of companies have been affected by the bust … a little more than a week after the Caixin report, the number of affected companies has risen to more than 600.” In reality the system had the stability of two drunks leaning against each other for support.

The linkage between these little known parts of the Chinese financial system and plunging real estate prices was highlighted by reports that businessmen in Wenzhou were desperately liquidating their properties assets to remain afloat — and those who failed to do this were literally taking to their heels or committing suicide. All too many enterprises were relying on the price of property rising forever.

Even the New York Times has woken up. Mark Mcdonald in an article titled “Apocalypse Soon” writes that he’s learned to speak the lingo.

Talk of an economic slowdown in China has become so loud and persistent that it now has its own slang: ghost cities, ghost fleets, rocket eggs, naked officials. The downturn has even led to the invention of a new financial algorithm, something called the China Stress Index — and the index remains high …

Foreign Policy magazine has a new overview of the economy called “Five Signs of the Chinese Economic Apocalypse.” (Business Insider sees that bet, and triples it, with a story headlined “Fifteen Reasons Why Everyone Is Suddenly Freaking Out About China.”) …

After a recent trip to China, Rosemary Righter wrote in The Times Literary Supplement of “tens of millions of houses and apartments as well as Ozymandian public buildings and factory estates — and what hits the eye is how much of it all stands empty. Across the country, uninhabited concrete blocks scab the land, not only in the megacities of the eastern seaboard but also in the sleepier southwest; from filthy mining towns in Henan, all the way to entire ghost towns in Inner Mongolia.”

And speaking of terms, the right word for China, says Jim Chanos in a Barron’s article, is “a thousand Dubais”. Everyone, the article the article says, who had “blind faith in the competence of Chinese authorities to manage through any cycle”, found it couldn’t.

If they had thought it through, those individuals should have realized that the problem with any authoritarian system which picks winners and losers, which has unlimited powers to “fix” the system, to paper things over, to inject money like Botox, here and there, to plump things up and thin things down eventually finishes up installing their incompetents everywhere. A thousand Dubais. A thousand Solyndras.  A thousand Chevy Volts. Now these same believers in managed economies are discovering what everyone eventually finds out. Nobody ever wins against arithmetic.

It’s also of note that even some of the longtime bulls are growing concerned on the nation’s future. One is William Overholt, a respected Asian scholar who has moved smoothly between Asian investment-banking posts, think tanks, including the Rand Corp., and academia; he’s now a senior research fellow at Harvard’s Kennedy School …

The so-called SOEs boast close family and financial ties to China’s ruling party clique. Power and wealth have become one in the same—a kleptocracy of insiders skimming off part of the prodigious money flows sluicing through the Chinese economy through relatives strategically placed in state companies, consulting firms, and various financial institutions.

Unless this blatant favoritism is curbed by the incoming administration of Xi Jinping, says Overholt, China faces the prospect of long-term stagnation—a prospect potentially far worse than that of Japan some 20 years ago.

If any of this sounds like Hope and Change, it should. It ought to be a warning that nothing — not even China, nor even the EU — is too big to fail. Sooner or later malinvestment, the waste of resources, the poisoning of the financial systems value database will come back to bite everyone. Will China reform, as Overholt hopes? When it snows in hell perhaps. Everyone at the top of the system will try to keep it going, like Wile E. Coyote until they go straight over the cliff. And they’ll keep going until inevitably, they look down.

The bad news is that everybody is along for the ride all the way to the bottom of the canyon.


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